“Anything that has happened economically, has happened over and over again.”

– Ray Dalio, founder, Bridgewater Associates, in Bloomberg interview

My thinking is impatient and mostly critical as I sift through research each week. I’m sure my “get to the point” personality frustrates my co-workers and I’m sure at times my beautiful wife.

It’s a personality flaw, I know; but hey, I’m just not sure any amount of therapy can help.

As I sift through research, my head clicks doesn’t matter, doesn’t matter… matters! Last week I wrote about Camp Kotok. There were some important “matters” moments. For example, there was an interesting moment when Bloomberg’s Mike McKee fired hard questions at the panel of economists and former Fed insiders.

Stress test very bright thinkers on stage with their peers and you get to watch their body language as you listen to their answers. Further, you get to watch the movements and facial expressions of others in the room. The panelists debated what the Fed will do next.

The most important takeaway from camp was confirmation of my view that the Fed, at the highest level, is heavily reliant on, if not married to, a limited equation called the Phillips Curve. The Fed’s goals are to keep employment strong and inflation in check.

The Phillips Curve is a single-equation empirical model, named after William Phillips, describing a historical inverse relationship between rates of unemployment and corresponding rates of inflation that result within an economy.

The Phillips Curve assumes that high levels of employment will pressure wages, increase incomes, increase spending and drive inflation higher. And that is true in the short-term debt (or business cycles) we move through over time, but is it always true? In my view, the answer is no.

I argued they need to consider where we are in terms of both the short-term and the long-term debt cycle. A retired senior Fed economist said to me, “Until someone comes up with a better model, it’s the best we’ve got.” At this moment in time, they are looking at the wrong thing. “Matters!”

Put “how the Fed will likely react” in the matters category. Put the Phillips Curve in the matters category simply because it is what the Fed is focused on and not because it is the right metric and put, as I mentioned last week, the understanding of short-term and long-term debt cycles and where we are within those cycles in the matters most category.

Bottom line: We sit at the end of a long-term debt cycle. One very few of us have ever seen before yet one that has happened many times over hundreds of years. The data exists. The Phillips Curve doesn’t see it.

I wrote last week, “… the Fed is Focused on the Obvious and the Unimportant.” That is important for us to know. But then, what should the central bankers and you and I be focused on? Let’s take a look at that today and see if we can gain a better understanding.

Meeting Bloomberg’s chief global economist Mike McKee at Camp Kotok was a real treat for me. If you have listened to Bloomberg radio over the years, you’ll know him as Tom Keene’s co-host. So how will the next few years play out? What does it mean in terms of the returns you are likely to receive? In the matters category, I believe this is what you and I need to know most.

Following are my abbreviated notes from a recent Keene-McKee-Ray Dalio video interview to better understand how the economic machine works and how Bridgewater uses this understanding to invest their clients’ money.

There are three main factors. There is productivity which produces income. You can spend at the end of the day what you earn. And what you earn is a function of your productivity. For a country it is the same as for individuals. You can be more productive if you work harder and you can be more productive if you are creative.

Over a short period of time you can spend more money than what you earn. That’s because we have debt. So we have debt cycles. There are two major debt cycles.

There is a short-term debt cycle which we are used to (it’s called the business cycle). We have recession and the Fed eases. What they do is reduce interest rates and as a result, money and credit goes out into the system.

It first bids up asset prices and then the lower borrowing costs enable business to make items that are cheaper because interest rates go down… so we have that business cycle. When that cycle gets past a certain mid-point in the cycle, there is a tightening of monetary policy as you get to the later part of the cycle (Fed raises interest rates) as you start to have inflation. It then gets too tight and the economy starts to go down. And that’s the business cycle. We are all used to this cycle.

So when we look at every country, we can see where we are in that cycle. We are in the mid-part of that cycle and hence we are having the conversation we are having about the Federal Reserve.

And then there is a long-term debt cycle because these cycles add up. In a long-term debt cycle, imagine you start off with no debt. Think of low debt-GDP ratios.

Say you’re earning $100,000 a year and you have no debt. You borrow $10,000 so you can spend $110,000. Your spending is somebody else’s income. They are earning more so they can spend more. And it becomes self-reinforcing until you get to the point where debts rise too high relative to the income (like a balance sheet, at some point you can’t borrow anymore because you owe too much relative to what you can make, your income).

Central banks, all central banks, are in the business of helping this process go along.

They lower interest rates, and lower again until rates hit 0% and we then come to a dilemma. We reach an end of monetary policy as we traditionally have it and as a result, you can’t keep that cycle going.

At this point the Fed puts money into the system. There is a difference between debt and money. With debt, for example, you go into a store and buy a suit, you put down your credit card and you later have to pay back money to settle the transaction. So the central banks can’t create credit because we’ve reached a point of too much debt so they put money in the system. They do this by buying financial assets.

When they buy bonds, the seller of those bonds takes the cash and he does something else with that cash. As a result of this, it causes longer-term yields to fall as the buying drives asset prices to rise.

So there are three equilibriums we have longer term:

The first equilibrium is debt can’t rise faster than your income for long.

The second equilibrium is that the operating rate in the economy can’t be too loose or too tight.

The third equilibrium is that in the capital markets structure. In other words, cash is going to have a lower yield than bonds which is going to have a lower return than equities and so on.

And there is an equilibrium that keeps working itself through this system and monetary and fiscal policy are the tools we use as we work through short-term and long-term debt cycles.

Tom Keene asks, “…we’ve enjoyed the last seven years. Where are we now within that equilibrium?” Dalio answered,

The United States is in the mid-point of its short-term debt cycle so as a result central banks are talking about whether we should tighten or not. That’s what central banks do in the middle of the short-term cycle and we are near the end of a long-term debt cycle.

You have interest rates going to zero. You have spreads that have come down (spreads are the difference between the yield you get on short-term bonds vs. the yield you get on long-term bonds).

So spreads that have come down mean that asset prices have gone up.

So now the expected return of asset classes (cash, stocks, bonds) are all very low.

We know that 1-year Treasury bonds are 2.25%. So you know that’s what you are going to get for the next ten years.

The equity price premiums look like 3½% or 4%.

So all of the asset classes now are aligned (returns on cash, fixed income and equities). As is normally the case.

If interest rates rise, then it will cause all of those assets to decline in value.

Tom Keene asks, “Within the framework of your economic machine, do you presume a jump condition (a jump up in rates) as central banks come out of this or can they manage it with smooth glide paths?” Ray answered,

I don’t believe they can raise rates faster than is discounted in the curve. In other words, the rate at which it is discounted to rise which is built into the interest rate curve (the curve is the different yields you get for short-term Treasury Bills to long-term Treasury Bonds). This is built into all asset prices.

So if you raise rates much more than is discounted in the curve, I think that is going to cause asset prices to go down. Because all things being equal, all assets sell at the present value of discounted cash flow. All assets are subject to this so if you raise rates faster than what is discounted in the curve, all things being equal, it will produce a downward pressure on all asset prices.

And that’s a dangerous situation because the capacity of the central banks to ease has never been less in our lifetimes. So we have a very limited ability of central banks to be effective in easing monetary policy.

Mike McKee asks, “What does a central bank do when you are at the end of a long-term debt cycle? When the Fed is at the zero bound (meaning a Fed Funds rate yielding 0%)?”

Ray believes the pressure on the central banks will be on easing monetary policy (lowering rates) vs. tightening (raising rates).

Ray said, “We are in an asymmetrical world where the risks of raising rates is far greater than lowering rates (this is due to where we sit in the long-term debt cycle including emerging market U.S. dollar denominated debt, commodity producing dollar denominated debts, Japan, Europe and China debts relative to GDP or their collective income).”

Meaning if you raise rates, it affects the dollar and it affects foreign dollar dominated debt. So the risks on the downside are totally different than the risks on the upside.

Ray suggests that the next big Fed move will be to ease and provide more QE.

McKee asks, “Do you think QE works anymore?”

Ray said, “It will work a lot less than it did last time. Just like each time it worked a lot less.” He’s saying we can’t have a big rate rise because of the amount of debt, because of what it will do to the dollar, because of the disinflation it will cause and we will have a downturn.

And the downturn should be particularly concerning because we don’t have the same return potential with asset prices richly priced, so each series of QE cannot provide the same bump. You reach a point where QE is simply pushing on a string.

You get nothing.

McKee asked if we are there yet.

Ray responded, “No, we are not there yet, but we are close. Some countries are there. Europe is there. What are you going to buy in a negative interest rate world?

Japan is there. The effectiveness of monetary policy then comes through the currency (SB here: currency devaluation makes your goods cheaper to buy than my goods).”

(SB here: QE creates money out of thin air and central banks use that money to buy assets. That money buys bonds from you and you then have money in your account to put to work. What will you then buy? Which country might you choose to invest?)

Ray said, “If you look at us (the U.S.), we have very high rates in comparison to those in Europe and Japan. So it comes through the currency. If you can’t have interest rate moves (like in Europe) it comes through the currency.” Countries need to get their currencies lower to compete and drive growth. Can you see the mess that debt gets us into and the challenges reached at the end of long-term debt cycles?)

I’m going to conclude my notes from the Bloomberg interview with this last comment from Ray:

If you can’t have interest rate moves, you’ve got to have currency moves. And that’s the environment we are in.

You’ll find the full interview below.

OK, my friend, I believe the Fed should be studying history. As I mentioned last week, they do talk with the likes of Bridgewater but it stops short of the top. I believe the Fed should be looking at what happens at periods in time when debt had reached, like today, ridiculous debt-to-GDP levels. That’s the road map. That’s the seminal issue. There are other important issues, of course, but I believe this one matters most. What I gained from my time at Camp Kotok was that the Fed is not reviewing history. They are not considering the dynamics of were we are in the long-term debt cycle. They are wed to the Phillips Curve. “Matters!”

How we reset the debt via a combination of monetary policy and fiscal policy will dictate a beautiful or ugly outcome. Risks are high because asset prices are significantly overvalued. Participate yes but have processes in place that protect. I believe the U.S. looks most favorable relative to the rest of the world and we will likely see more QE. I believe the Phillips Curve and the Fed’s desire to normalize rates (to put them in a better position to deal with the next cycle) will prove to be a mistake. As Ray said, “The risks are asymmetric.” The current rate hike period will be halted and more QE will follow.

What happens between now and then? Don’t know. I suspect a shock followed by more global QE. The current state favors a stronger dollar and a strong U.S. equity market especially if there is a sovereign debt crisis in Europe. So yep… there’s that. Participate and protect and tighten your seat belt. Likely to be bumpy.

Grab a coffee. There was a great piece from GMO titled, “The S&P 500: Just Say No.” It highlights how GMO comes to their 7-Year Real Asset Return Forecast. One that is currently predicting a -4.20% annualized real return over the coming seven years. As in a loss of nearly 4% per year. If true, expect every $100,000 of your wealth to equal $70,945 seven years from now. Ultimately, valuations do matter. So yep… that too.

GMO has posted its forecast for many years. It is updated monthly. The accuracy rate has been excellent. Meaning the correlation to what they predicted to what returns turned out to be is very high. Not a guarantee, but put it too on your matters list. You can follow it here.

You’ll find a few interesting charts. Thanks for reading. I hope you find this information helpful for you and your work with your clients. Have a great weekend.

Fear of financeFinancial stability is a growing concern of central Banks

China’s central bank has more cause to worry than the Fed or the ECB

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CENTRAL bankers have gathered at their annual shindig in Jackson Hole, Wyoming, for the past ten years with only one thing on their minds: the health of the global economy. This year’s gathering is different. The bankers’ preoccupations are changing, from recovery to financial stability.

Oddly, rising concern about the risks of financial excess is good news. It reflects the arrival of the first synchronised global economic upswing since 2010. GDP growth in the quarter ending in June was the most rapid since then, according to JPMorgan Chase, thanks to stronger-than-expected activity in China, Japan and Europe (Britain was a notable exception). Any relief, however, is mixed with anxiety that the excesses which led to the crisis of 2007-08 are again pervasive.

Policymakers have helped support the economy over the past decade. But by keeping interest rates low, they have also spurred investors to take extra risks in search of larger returns. The American stockmarket is on a cyclically adjusted price-earnings ratio of 30—a level surpassed only in 1929 and the late 1990s. Investors are rushing to buy government debt from risky countries. Argentina has defaulted on its debts six times in the past century, but still easily found buyers for a 100-year bond in June. Earlier this month buyers snapped up Iraq’s first independent bond issue for more than a decade.

The tension between growth and stability is most obvious in China. The IMF this month simultaneously raised its growth forecasts and warned that the country was gorging itself on debt, which jumped from 150% of GDP in 2007 to 280% in 2016. Since the start of this year, the People’s Bank of China has restricted the supply of short-term liquidity to banks.

Regulators have also ordered them to account for loans hidden off their balance-sheets. So far, so good: funding costs have risen and overall credit growth has slowed even as nominal growth has rebounded. But the economy has recently started to lose momentum. Will China continue efforts to constrain credit even when growth dips below official targets? The fear is that it will revert to type and let credit surge again.

Concerns about financial fragility are of a very different kind in Europe, where a recovery is gaining strength. Since December, when the European Central Bank lowered its target for asset purchases, to €60bn ($70bn) a month, there has been speculation that the ECB’s programme of quantitative easing (QE, the creation of money to buy assets) must wind down soon. But the bank is nervous about a repeat of the “taper tantrum” of 2013, when markets were spooked by signals from the Fed that it would be stopping QE. A hurried withdrawal of QE might cause a sudden rise in bond yields as bubbly assets are repriced. That could hurt countries, such as Italy, with big public-debt burdens.

The Federal Reserve sits somewhere between China and Europe. The American economy has been expanding for years; only twice in its history has it grown for more consecutive quarters.

Its financial system looks robust. But here, too, queasiness about share prices and the lengths to which investors will go to buy bonds with decent yields has crept into the Fed’s deliberations.

As the crisis of 2007-08 fades from memory, the Fed is worrying about the efforts of the Trump administration to loosen the shackles that bind the banks. Stanley Fischer, its vice-chairman, has opposed proposals from the Treasury that “stress tests” of big banks should be softer.

Alarm bells

It is right that central banks should be vigilant about threats to financial stability. But the Fed should not yet put concerns about risk-taking above the immediate demands of the economy.

American banks are well-capitalised; and there is a decent case for simplifying some post-crisis regulations, particularly those that bind America’s smaller lenders. As for the euro zone, its recovery is still recent and continues to need support; the ECB should not be withdrawing stimulus abruptly in any case. For China the real test lies ahead, perhaps as early as next year.

Tensions between growth and stability will become more acute as time goes on. But as the central bankers descend on Wyoming, it is too soon for them to stop worrying about the health of the world economy.

It had a good run. But the end is in sight for the machine that changed the world

“HUMAN inventiveness…has still not found a mechanical process to replace horses as the propulsion for vehicles,” lamented Le Petit Journal, a French newspaper, in December 1893. Its answer was to organise the Paris-Rouen race for horseless carriages, held the following July. The 102 entrants included vehicles powered by steam, petrol, electricity, compressed air and hydraulics. Only 21 qualified for the 126km (78-mile) race, which attracted huge crowds. The clear winner was the internal combustion engine. Over the next century it would go on to power industry and change the world.But its days are numbered. Rapid gains in battery technology favour electric motors instead. In Paris in 1894 not a single electric car made it to the starting line, partly because they needed battery-replacement stations every 30km or so. Today’s electric cars, powered by lithium-ion batteries, can do much better. The Chevy Bolt has a range of 383km; Tesla fans recently drove a Model S more than 1,000km on a single charge. UBS, a bank, reckons the “total cost of ownership” of an electric car will reach parity with a petrol one next year—albeit at a loss to its manufacturer. It optimistically predicts electric vehicles will make up 14% of global car sales by 2025, up from 1% today. Others have more modest forecasts, but are hurriedly revising them upwards as batteries get cheaper and better—the cost per kilowatt-hour has fallen from $1,000 in 2010 to $130-200 today. Regulations are tightening, too. Last month Britain joined a lengthening list of electric-only countries, saying that all new cars must be zero-emission by 2050.The shift from fuel and pistons to batteries and electric motors is unlikely to take that long. The first death rattles of the internal combustion engine are already reverberating around the world—and many of the consequences will be welcome.To gauge what lies ahead, think how the internal combustion engine has shaped modern life. The rich world was rebuilt for motor vehicles, with huge investments in road networks and the invention of suburbia, along with shopping malls and drive-through restaurants. Roughly 85% of American workers commute by car. Carmaking was also a generator of economic development and the expansion of the middle class, in post-war America and elsewhere. There are now about 1bn cars on the road, almost all powered by fossil fuels. Though most of them sit idle, America’s car and lorry engines can produce ten times as much energy as its power stations. The internal combustion engine is the mightiest motor in history.But electrification has thrown the car industry into turmoil. Its best brands are founded on their engineering heritage—especially in Germany. Compared with existing vehicles, electric cars are much simpler and have fewer parts; they are more like computers on wheels. That means they need fewer people to assemble them and fewer subsidiary systems from specialist suppliers. Carworkers at factories that do not make electric cars are worried that they could be for the chop. With less to go wrong, the market for maintenance and spare parts will shrink. While today’s carmakers grapple with their costly legacy of old factories and swollen workforces, new entrants will be unencumbered. Premium brands may be able to stand out through styling and handling, but low-margin, mass-market carmakers will have to compete chiefly on cost.Assuming, of course, that people want to own cars at all. Electric propulsion, along with ride-hailing and self-driving technology, could mean that ownership is largely replaced by “transport as a service”, in which fleets of cars offer rides on demand. On the most extreme estimates, that could shrink the industry by as much as 90%. Lots of shared, self-driving electric cars would let cities replace car parks (up to 24% of the area in some places) with new housing, and let people commute from far away as they sleep—suburbanisation in reverse.Even without a shift to safe, self-driving vehicles, electric propulsion will offer enormous environmental and health benefits. Charging car batteries from central power stations is more efficient than burning fuel in separate engines. Existing electric cars reduce carbon emissions by 54% compared with petrol-powered ones, according to America’s National Resources Defence Council. That figure will rise as electric cars become more efficient and grid-generation becomes greener. Local air pollution will fall, too. The World Health Organisation says that it is the single largest environmental health risk, with outdoor air pollution contributing to 3.7m deaths a year. One study found that car emissions kill 53,000 Americans each year, against 34,000 who die in traffic accidents.Autos and autocraciesAnd then there is oil. Roughly two-thirds of oil consumption in America is on the roads, and a fair amount of the rest uses up the by-products of refining crude oil to make petrol and diesel. The oil industry is divided about when to expect peak demand; Royal Dutch Shell says that it could be little more than a decade away. The prospect will weigh on prices long before then. Because nobody wants to be left with useless oil in the ground, there will be a dearth of new investment, especially in new, high-cost areas such as the Arctic. By contrast, producers such as Saudi Arabia, with vast reserves that can be tapped cheaply, will be under pressure to get pumping before it is too late: the Middle East will still matter, but a lot less than it did. Although there will still be a market for natural gas, which will help generate power for all those electric cars, volatile oil prices will strain countries that depend on hydrocarbon revenues to fill the national coffers. When volumes fall, the adjustment will be fraught, particularly where the struggle for power has long been about controlling oil wealth. In countries such as Angola and Nigeria where oil has often been a curse, the diffusion of economic clout may bring immense benefits.Meanwhile, a scramble for lithium is under way. The price of lithium carbonate has risen from $4,000 a tonne in 2011 to more than $14,000. Demand for cobalt and rare-earth elements for electric motors is also soaring. Lithium is used not just to power cars: utilities want giant batteries to store energy when demand is slack and release it as it peaks. Will all this make lithium-rich Chile the new Saudi Arabia? Not exactly, because electric cars do not consume it; old lithium-ion batteries from cars can be reused in power grids, and then recycled.The internal combustion engine has had a good run—and could still dominate shipping and aviation for decades to come. But on land electric motors will soon offer freedom and convenience more cheaply and cleanly. As the switch to electric cars reverses the trend in the rich world towards falling electricity consumption, policymakers will need to help, by ensuring that there is enough generating capacity—in spite of many countries’ broken system of regulation. They may need to be the midwives to new rules and standards for public recharging stations, and the recycling of batteries, rare-earth motors and other components in “urban mines”. And they will have to cope with the turmoil as old factory jobs disappear.Driverless electric cars in the 21st century are likely to improve the world in profound and unexpected ways, just as vehicles powered by internal combustion engines did in the 20th. But it will be a bumpy road. Buckle up.

The concept of phyles originated with the sci-fi writer Neal Stephenson, in his seminal book The Diamond Age. I’ve always been a big fan of quality science fiction. I’m not sure why it’s true, but there’s no question sci-fi has been a vastly better predictor of both social and technological trends than absolutely anything else.The book, set mostly in China in the near-term future, posits that while states still exist, they’ve been overwhelmed in importance by the formation of phyles. Phyles are groups of people that get together with others, bound by whatever is important to them. Maybe it will be their race, religion, or culture. Maybe their occupation or hobby. Maybe their world view or what they want to accomplish in life. Maybe it’s a fairly short-term objective. There are thousands—millions—of possibilities.The key is that a phyle might provide much more than a fraternal or beneficial organization (like Rotary or Lions) does. I take the concept quite seriously in my daily life. It’s one reason I don’t believe in organized charity. Phyles might provide insurance services very effectively, since a like-minded group—held together by peer pressure and social approbation—eliminates a lot of moral risk. It might very well offer protection services; a criminal might readily take out a citizen “protected” by a state, but they’ll think twice before attacking members of the Mafia.People are social. They’ll inevitably organize themselves into groups for all the reasons you can imagine. In the past, technology only allowed people to organize themselves by geography—they had to be in the same area. That’s been changing, especially over the last century, with the emergence of the train, the car, and especially the airplane. The same with communication. The telephone and television were huge leaps, but the Internet is the catalytic breakthrough. It’s now possible for people to reach out all over the world to find others that are their actual countrymen, not just some moron that shares a piece of government ID with them.As things develop, people will find out—or create places—where their loyalties lie. The nation-state has mostly been an inefficient, counterproductive, and expensive nuisance; it’s rapidly becoming completely insufferable. And dangerous; the people living off the state (which is to say acting as parasites upon their “fellow citizens”) are going to resist having their rice bowls broken. Undoubtedly they’ll use the coercive powers of the state to try to maintain the status quo. The military and the police (whose loyalties are first to their coworkers, then to their employer, and only then to those whom they’re supposed to “serve and protect”) will be out in force wearing riot gear.If the last major change in social structure was catalyzed by the printing press, it’s pretty easy to see how the Internet serves that function today. But what will facilitate it, the way gunpowder did? My bet is on some type of nanotechnology.I’ve long been a fan of nanotech as a world changer. Technology has always been the friend of freedom and the common man. Sure, the powers of suppression usually get first access to it and always try to monopolize it and use it to keep the “masses” under control, but in the end the cat always gets out of the bag. Even though the state is using an intimidating variety of technologies to keep its subjects under control, technology is evolving much faster and spreading much more broadly, to the benefit of people in general. The end of the state will be precipitated by the Nanotech Revolution. In the years to come, nanotech will, in many ways, be an analog of gunpowder. But thousands of times more potent.It will do a number of things to totally overturn the current world social order. It will, among many other things, show that (at a minimum) the state no longer serves a useful purpose. And will act as the means to facilitate treason… simply because it’s logical, if nothing else.But I’m jumping just slightly ahead of the story. Nanotech is going to become the major force in the world over the next generation. But you’re not going to have to wait nearly that long for all this stuff to start happening.Let me draw your attention to two important things that are just starting to happen, right now, that are going to lead to a New World Order. But not at all like the one envisioned by Bush and Kissinger.

Economic Collapse

I’m not going to spend a lot of time on this. If you’ve been reading our publications for any length of time and don’t think we’re in for something unprecedented, then we haven’t been nearly as clear—and alarmist—as we meant to be. Economic collapse doesn’t mean the world is going to come to an end; it just means there’s going to be a major change in who owns what and how things are produced and consumed. Our main focus is to suggest investments that should not only weather the building hurricane but allow you to profit from it.The purpose of articles like this one is to try to put all that in context. One thing that’s going to militate towards the creation of phyles is the breakdown of the ability of governments to provide the services that people expect from them. At the same time that they’re extracting hugely more in taxes, they’ll be beset by inflation, economic depression, financial chaos, and regulatory havoc. People will increasingly realize the state isn’t a cornucopia that can solve their problems but is, in fact, actually the main cause of their problems. They’ll start withdrawing loyalty from it.People will start organizing themselves into incipient phyles (although they probably won’t call them that), using the Internet. The governments of the world will increasingly clamp down on the Net, recognizing it for the subversive medium that it is, seeing that it’s defrocking their game.Among other things, economic distress usually leads to military action, as governments try to find an outsider to blame for their problems. The tendency is compounded by the perversely wrong-headed notion that a war can somehow cure a depression. This time around, I expect military events will play a significant part in the sea change—just as they did during the agricultural and industrial revolutions.

Military Collapse

Like any bureaucracy, the military is completely predictable and so is again fighting the last war. Spending $400 million on a single F-22, $2 billion on a single B-2, and many billions on a single aircraft carrier is simply crazy. These technically amusing toys would have been helpful for fighting the armed forces of another nation-state—like those of the USSR, but those largely disappeared decades ago. In today’s world, with a near total shift to unconventional warfare, they’re about as valuable as cavalry.Besides, the attack won’t come from Russia, which is on its way to demographic, economic, and political collapse anyway. Or from China. It’s clear to them they don’t need a military confrontation when it’s just a matter of time before they win through economics and demographics.The real military threat to the U.S. (and China, Russia, and all the other nation-states) is what’s evolving in Iraq and Afghanistan. On the one hand, these wars can be viewed as a continuation of the Crusades. The average Muslim takes his religion much more seriously than the average Christian. Maybe that’s just because Islam is a simpler religion. More likely though, it’s because Muslims are much poorer and generally more backward than the West; it might be said they’re still sociologically where the West was during the Middle Ages.Be that as it may, there are 1.3 billion of these folks, and they feel badly treated. Osama spelled out, clearly and publicly, the three reasons for the current jihad—of which the average American is totally ignorant. One, Western support of Israel. Two, the presence of Western troops in Islamic countries.Three, Western support of corrupt puppet governments throughout the Islamic world (almost all of them, but prominently including Egypt, Saudi Arabia, Pakistan, and Iraq). His views are factually correct. And the facts greatly antagonize hundreds of millions of poor Muslims, who subsequently feel they have a lot to gain, and almost nothing to lose, by fighting the infidel.But what’s the nature of this War Against Islam, which shows every sign of heating up in Iraq and Afghanistan and spreading catastrophically to Pakistan and Iran? And beyond.It’s not a war against another nation-state; those governments are pathetically incapable of fighting a real war. Their armies are now, and always have been, used exclusively for suppressing the population.Because they aren’t uniformed and organized into conventional units, and because they attack only small or soft targets, the mujahidin (“terrorists” to Boobus americanus ) look like the guerrillas we saw in the 20th century. But they’re not. They aren’t fighting a war of liberation. They don’t have a central command. And they’re not actually trying to overthrow a government. Stupidly, the US government is responding by using all kinds of impressive and very expensive hi-tech devices to kill small numbers of fighters. Which is not only non-productive, it’s totally counterproductive. Every fighter who’s killed (forget about innocent wedding parties) gives rise to ten more young, motivated fighters. And these people have the highest birthrates in the world.This isn’t like fighting the Vietnamese, where there was at least a leadership hierarchy. It’s not like fighting ants or bees, where if you kill the queen, you win. It’s more like killing cockroaches in your apartment, when they infest the entire building.Sidebar here. I’m not using the word stupid as a pejorative, or because I can’t find a thesaurus. Nor am I using it to denote a low IQ; some people in the US government have quite high IQs. I’m using it in either of two other senses. One: as the inability to predict the consequences of actions. Two: as an unwitting tendency towards self-destruction.Anyway, it’s stupid to focus on things like Osama’s Al-Qaeda. That organization was just a flag planted in the sand, to draw attention to the cause. The movement has long since metastasized, and there are now undoubtedly hundreds of informal little organizations, some of whom are friendly toward each other, some of whom are bitter rivals. But all of whom share a common goal. They all watch each other and learn from what the other does.It’s like the early days of the auto business, when there were hundreds of companies. They were all innovating as rapidly as they could and all watching each other in order to profit from each other’s advances. They didn’t particularly like each other and were in true competition, but they had the same goal, and everyone immediately applied advances in technology that anyone else made. Unstoppable.By comparison, the US is like GM today. It’s got a research lab that comes up with good stuff now and then, but at a huge cost. And whatever it does come up with is applied slowly, bureaucratically. It will be completely overwhelmed by what amounts to a military marketplace.Which is another point. The mujahidin buy all their technology off the shelf. They may be poor and superstitious, but they’re not stupid in the way they’re dealing with the US. We attack them with a million-dollar (hard cost only) missile; they counterattack with a $1,000 IED. We attack them with an airstrike, using hundreds of millions of dollars of aircraft; they counterattack with a suicide bomber, at about zero cost. The US takes out one of their leaders; they attack a city like Paris and create mass hysteria.In the near future, you’ll find these people carrying out mass and random assassinations. Blowing up power transformers. Cutting fiber-optic and electrical cables. Doing nasty things in the air-conditioning systems of high-rise buildings. Sit down and brainstorm for 15 minutes about what you’d do if you really wanted to punish The Great Satan. If you don’t scare yourself, then you don’t have much imagination. Their return on investment is almost infinite. That assures the US will go bankrupt on the path it’s currently on. They don’t need NSA supercomputers; all they need is a few laptops, cell phones, some stuff you can buy at Radio Shack, instructions on the Internet, and a few buddies who share a common goal. And none of this postulates nanotech devices, which will be created in thousands of garages in the years to come.A determined guerrilla war is almost impossible to win, as the French found in Algeria and the Americans found in Vietnam. The reason is that if you’re fighting guerrillas, you’re almost certainly fighting the average guy in a country—which means you’ve got to kill almost everybody to win. If you’re fighting a guerrilla war, be assured you’re an outsider, and you’re on the wrong side (even if you think you’re the good guy).An open-source guerrilla war (to use computer jargon) is a new thing and much worse from the nation-state’s point of view. For one thing, it’s truly impossible to win. That’s for the same reason the behemoth IBM had its lunch eaten first by Apple (founded by a couple of hippies in a garage), then the PC (with thousands of independents writing code, strictly on their own). It’s the nation-state fighting hundreds of what amount to phyles, whose main common denominator, at the moment, is that they’re all Islamic. But that’s going to change soon.What’s going to happen? The US is going to lose this undeclared war catastrophically. The defeat is going to occur, in part, because it’s going to accelerate the ongoing bankruptcy of the US. The US is also going to be soundly defeated on a strictly military level. A nation-state can no more win against phyles than tribes could win against kingdoms. And nanotechnology, which will give individuals the power that only armies once had, is just in its very beginnings.Incidentally, phyle warfare is going to spread way beyond the Muslim world. My guess is that will occur in at least two other circumstances: the unwinding of dysfunctional colonial structures in most Third World countries, and internal economic collapse in some advanced countries.You’re going to see this all over Africa and all over the parts of the world the Europeans colonized, creating artificial nation-states by drawing arbitrary lines on maps, with no regard for who was already living there. About 100 countries in the world have absolutely no business being countries to start with. Lots of little phyles are going to spring up, not to take over the collapsing governments of Africa (which are nothing but vehicles for theft anyway) but to facilitate their destruction and replace them by something local. Or nothing.The Europeans and Americans will call them “failed states”—an accurate description. But they’re too stupid to realize that a failed state is actually a good thing today—the next stage of what’s going to happen. Somalia provides an early indicator. Governments, with their hugely expensive capital ships, are completely incapable of preventing teenagers in dinghies from controlling a major sea lane. Worse, governments are preventing commercial ships from arming their crews so they can effectively engage the boarders. Governments are incapable of protecting merchants, only capable of preventing merchants from protecting themselves.Phyle warfare isn’t going to be restricted to Africa, the Islamic world, and the like. It will arrive in America. All kinds of groups—outlaw bikers, skinheads, religious right types, local sovereignty enthusiasts, young Hispanics, and groups of every kind—could easily form loose networks, as opposed to tight organizations, sharing little more than dissatisfaction with the status quo.The world has been evolving ever more rapidly as time goes by. The recent rise to legitimacy of so-called NGOs (non-governmental organizations) is another straw in the wind. I’ll bet the next change is going to be turbo-charged. And bigger than anything that we’ve seen, or read about, so far. The Greater Depression may just serve as a background for all this—just a sideshow in a much bigger circus.

- Copper has rallied over 50% from the bear market lows.- But it looks toppy here for a number of reasons.- How copper, gold, equities and inflation are configured looks very like the 2000 market top.

Copper (JJC) broke strongly to new 2017 highs in July. The collapse of the Trump trade and reflation themes didn't seem to concern buyers too much.

Funds are holding a record net long position.

And this is how price is responding.

So far, so bullish. What could go wrong?

Well actually lots could. As most know, copper is related to growth and inflation, and inflation looks like it has peaked for now, despite the Fed insisting the dip is 'transitory'.

Sure, inflation could turn back up, or copper could just ignore it for a while, but looking back at similar situations suggests otherwise.

The 1999 Comparison

Many analyst have compared the current stock market with the 1999-2000 bubble. Eventually they will be right, but one reason many analysts have been wrong and early is because they didn't look across a variety of markets.

Copper bottomed in 1999 after a significant bear market and made a +50% recovery over the next 18 months into the September 2000 top. Equity bears in 2015 and 2016 would have saved themselves a lot of pain if they had waited for copper to do this again. And now it has.

The reversal and pickup in inflation from 2015-2017 is comparable to 1998-2000 after it reversed a two-year downtrend. However, as the stock market peaked and crashed from 2000-2002, inflation reversed back down again.

Superimposing the inflation rate on copper during both periods, we can see how similar the interactions are in both periods.

Inflation had already peaked in March 2000 and was turning down as copper made its last rally into the September 2000 top. It may be doing the same now.

The Fed raised four times in 2000 and we can say with hindsight they were much too aggressive. With three hikes in the past nine months and plans for balance sheet reduction, could we say the same of today's Fed with foresight?

Other markets seem in a similar position to 2000. The equity comparison is well known, but gold also fits the period; the way it bottomed and rallied in 2015-2016 is comparable to 1999-2000.

Over the medium term, I see it heading towards the lows again with copper. Many expect gold to shoot higher if equities fall, but history tells us otherwise.

Technicals

I use Elliott Wave to identify cycles of buying and selling in different markets. Copper looks to be in wave 5 - the last wave - of the current cycle from the lows.

Wave 5 is associated with momentum divergence (which is evident in the lower pane of the chart), as well as deteriorating fundamentals (i.e. inflation falling). Sentiment is the real driver of price and we know from the very first chart how sentiment must be very frothy as positioning is so extreme on the long side.

Once wave 5 is complete, a 61.8% Fibonacci retrace is normal, but I would target the November 2016 pre-election lows of $2.25 if equities start to fall significantly.

I would expect copper to top out around $3.1, near the top of the channel.

Conclusions

Copper has its own fundamentals based on supply and demand, but it is also a valuable piece in the cross-asset puzzle. How copper, gold, equities and inflation are currently configured is very similar to the market top of 2000. This doesn't bode well for any market.

Concentrating on copper alone, the technicals, sentiment, and positioning, plus the decoupling with inflation, suggest that we should be wary of the seemingly bullish move higher. Regardless of any historical comparisons, copper looks to be heading lower over the medium term.

Job approval numbers for Japan’s Prime Minister Shinzo Abe are in freefall. Abe's support has now fallen below 30%, and his Liberal Democratic Party recently suffered heavy losses stemming from a slew of scandals revolving around illegal subsidies received by a close associate of his wife. But as we have seen back on this side of the hemisphere, the public’s interest in these political scandals can be easily overlooked if the underlying economic conditions are favorable. For instance, voters were apathetic when the House introduced impeachment proceedings at the end of 1998 against Bill Clinton for perjury and abuse of power. And Clinton’s perjury scandal was indefensible upon discovery of that infamous Blue Dress. The average citizen, then busily counting their chips from the dot-com casino, were disinterested in Clinton’s wrongdoings because the 1998 economy was booming. Clinton remained in office, and his Democratic party gained seats in the 1998 mid-term elections.Therefore, Abe's scandal is more likely a referendum on the public’s frustration with the failure of Abenomics.When Shinzo Abe regained the office of Prime Minister during the last days of 2012, he brought with him the promise of three magic arrows: an image borrowed from a Japanese folk tale that teaches three sticks together are harder to break than one. The first arrow targeted unprecedented monetary easing, the second was humongous government spending, and the third arrow was aimed at structural reforms. The Prime Minister assured the Japanese that his “three-arrow” strategy would rescue the economy from decades of stagnation.Unfortunately, these three arrows have done nothing to improve the life of the average Japanese person. Instead, they have only succeeded in blowing up the debt, wrecking the value of the yen and exploding the Bank of Japan’s (BOJ) balance sheet. For years Japanese savers have not only seen their yen denominated deposits garner a zero percent interest rate in the bank; but even worse, have lost purchasing power against foreign currencies. The yen has lost over 30 percent of its value against the US dollar since Abe regained power in 2012.Meanwhile, the Japanese economy is still entrenched in its “lost-decades” morass; and growing at just over one percent year over year in Q1 2017. Japan’s dramatic slowdown in growth, which averaged at an annual rate of 4.5 percent in the 1980s, fell to 1.5 percent in the 1990s and never recovered. In addition to this, higher health care costs from an aging population have driven government health care spending to move from 4.5 percent of GDP in 1990, to 9.5 percent in 2010, according to IMF estimates.Incredibly, this low-growth and debt-disabled economy has a 10-Year Note that yields around zero percent; thanks only to BOJ purchases.Prime Minister Abe’s plan to address this recent scandal-driven plummet in the polls is to increase government spending even more and have the BOJ simply step up the printing press. In other words, he is going to double down on the first two arrows that have already failed! However, the Japanese people appear as though they have now had enough.Japan's National Debt is already over a quadrillion yen (250% of GDP). And the nation would never be able to service this debt if the BOJ didn’t own most of it. The sad truth is that the only viable alternative for Japanese Government Bonds (JGBs) is an explicit or implicit default. And, a default of the implicit variety has already occurred because the BOJ now owns most of the government debt—total assets held by the BOJ is around 93% of GDP; JGBs equal 70% of GDP.

Japan is a paragon to prove that no nation can print, borrow and spend its way to prosperity. Abenomics delivered on all the deficit spending that Keynesians such as Paul Krugman espouse. But where is the growth? Japanese citizens are getting tired of Abenomics and there are some early indications that they may vote people in power that will force the BOJ into joining the rest of the developed world in the direction of normalizing monetary policy.The reckless policies of global central banks have left investors starving for yield and forcing them out along the risk curve. But interest rates are set to rise as central banks remove the massive and unprecedented bid on sovereign debt—perhaps even in Japan. A chaotic interest rate shock wave is about to hit the global bond market, which will reverberate across equity markets around the world. Is your portfolio ready?

Jordan Bitterman, CMO of IBM's The Weather Company, talks with Wharton's Catharine Hays about marketing in the realm of technology.

As the digital revolution keeps on turning, cutting-edge companies are looking to artificial intelligence to spur the next wave of change. This specialized technology holds great promise for those willing to employ it, but it also comes with challenges. Consumers are familiar with AI in the form of Google’s Alexa, Apple’s Siri or IBM’s Watson. Jordan Bitterman is the chief marketing officer for The Weather Company, an IBM business. He recently spoke to Catharine Hays, executive director of the Wharton Future of Advertising Program, about creativity and marketing in the realm of technology for a segment on the Marketing Matters radio show, which airs onSiriusXM channel 111. (Listen to the full podcast using the player above.)

Catharine Hays: We like to say that marketers have some of the most interesting backgrounds. Tell us about your journey to get to this role.Jordan Bitterman: Mine has been a little nontraditional. I spent most of my career at large advertising agencies. That part isn’t necessarily nontraditional, but I did it as a media planner and media strategist. My job was not to create the ads but to determine where the ads go. Most people who follow a CMO track come from account management, which is the team that leads all of the client relationships.My past was through media, and I started at a time when media was beginning to change in major ways. It was back in the time when a media person simply had to understand an audience, a demographic such as women or men, 18 to 34. But early in my career, understanding audiences started to get far more dynamic and more sophisticated, and that was largely driven by the advent of digital. It became harder to reach people, and it meant that those of us who did media for a living had to become far more strategic ourselves.Digital media changed everything throughout the advertising industry. I have found that being involved in these leading-edge areas, whether it be web or mobile or social or content, really interested me and helped me along in my career.

Hays: How did you get connected with The Weather Channel?Bitterman: I joined Weather after the acquisition with IBM. I’ve been here for a little less than a year. I had started thinking about, what does the second half of my career look like? Is it on the agency side or somewhere else? I really zeroed in on the publisher side. But I didn’t want to just work for a publisher who was a content creator solely, I was really drawn to the idea of weather, but more importantly the idea of AI and the Internet of Things. I saw both of those areas incredibly burgeoning. They were areas that I really wanted to focus on. The idea of data as a business, not just content as a business, was something that really appealed to me.Hays: Maybe you can give us a little background? I’ve been calling it The Weather Channel, but it’s The Weather Company. Why did IBM acquire The Weather Company?Bitterman: It’s a confusing point that a lot of people mistake from time to time. It requires a very simple explanation, which is that IBM acquired The Weather Company inclusive of everything The Weather Company has with the exception of the cable network that is The Weather Channel. They are now a client of ours. We license them our meteorology, and that’s how they run their cable network. But everything else — the app, the website, all of the data — were purchased by IBM. The main reason for that is that weather is a huge driver of business outcomes.If you were to look at the earning statements from companies across the board, weather is often a primary reason cited for businesses not hitting their targets for a quarter. IBM, being in the business of helping businesses make better decisions, drive outcomes, obviously saw that as an opportunity. We’re not just forecasts. There’s an underlying platform that fits as a foundation element. IBM is now investing heavily in IOT and cognitive analytics. That was the reason why we were an attractive acquisition for IBM.Hays: Tremendous amount of data, tremendous impact on businesses, and a tremendous predictive capability as well — those are three really powerful reasons for gaining all of that wealth.Bitterman: Absolutely. I’ll give you a couple of statistics. These are things I did not know when I took this job, and they are data points that I have put in front of our clients and customers. We do roughly 25 billion forecast calls per day, and those originate from all sorts of data sources around the world. We do around two to 2.2 billion on an average day of location. Those 25 billion forecast calls are originating, pinging to and from two billion locations a day. It makes us one of the largest IOT platforms in the world.Hays: In what regard is that IOT?Bitterman: For instance, we do a lot of business with the airline industry, so the data sources need to come from not just Chicago, Illinois or Philadelphia. They need to come from towers and sensors and pings all over the place in order to be able to realistically have a chance at identifying whether they should put a plane in the air or if they should keep it on the ground. There are sensors inside of the planes. There are sensors throughout the United States. That is the Internet of Things at least in many ways…. When we get down to it, the real mission-critical, bread-and butter elements of IOT are what is sitting in elevators and airplanes and turbines.Hays: Watson is The Weather Company’s new best friend. Give us a brief history of Watson, which I think really has been this country’s first interaction with artificial intelligence.Bitterman: It’s almost a foregone conclusion that someone who talks about Watson will start with talking about “Jeopardy!” It started as a way of demonstrating whether it could work or not, and almost internally than externally. It started as one natural language, QA, question and answer, application program interface (API). Today, it is represented by a whole diverse set of Watson’s services that span everything from language to speech to vision, etc.You may recall that Watson went on “Jeopardy!” and won. It was the first time that we, as a technical society, really started thinking in many ways that computing can get into more than just binary. Watson is best understood by thinking about it through the three eras of computing. The first was the tabulating era. Think about Imitation Game, the movie about Alan Turing. It was essentially calculations. That’s practically up to the 1950s. Punch cards, etc.

From there we went into the programming era, and that was about using computers to help solve equations where we know what the answers are, or we know generally where the answers are going to lie, but we want to get there faster and more easily. When I think about the programing era, I think about Excel. But you could pretty much think about any other piece of software that we’ve used over the decades.But now we’ve entered the cognitive era. What separates the tabulating era and the programming era from the cognitive era is that we can use structured and unstructured data. It’s not just zeroes and ones. We can lean into unstructured data like video or audio or faces, expressions. The idea that you and I could be sitting across a table from each other and I can read and react to your expressions based on whether you think I’m saying something smart or something kind of off. Computers can start to do that now, and that’s really what Watson is trying to do. It’s trying to learn, understand, reason and interact back. A definition of cognitive that I particularly like is: Programming is where people program computers, but cognitive is where computers program themselves. Certainly, with the aid of people, but they can start to program themselves, and that’s when things get super interesting.Hays: That’s a really good distinction. Tell us about how Watson has pervaded IBM. Help us to navigate how IBM is thinking and organizing around it.Bitterman: Obviously, IBM is a very big company with many divisions that solve problems and challenges for clients across the world. Watson is two things. It’s divisions within IBM, and it’s also offerings that help drive some of the other divisions within IBM. The Watson content and IOT platform is part of a broader Watson ecosystem, and that broader ecosystem addresses health care, financial services, retail, education, legal. There is development that goes on at Watson. There are teams of engineers and technologists who are building out more aspects of the program. It launched in one language, but it’s being trained in eight additional languages now including German and Korean. It’s a diverse set of services that span language and speech.For our group specifically, we’re made up of a few different parts of the business. We’re made up of an IOT platform. I liken it a lot to the Romans and the aqueducts. There was water. We knew we needed water. We had to get water from one place to another because without it you couldn’t irrigate your fields, you couldn’t drink the water, you couldn’t make wine. Once you built the aqueducts, all of a sudden water was set free and could be used in so many places. That’s what we’re doing with the IOT platform as it relates to data. How can we take data and make it more useful? Certainly, there’s data that is useful all over the place right now; we’re not really stretching for data in this world. But there’s so much more data, like the data I’ve talked about before that come from elevators and airplanes, that we’re not using enough of yet. That IOT platform is charged with that.A large part of our business is The Weather Company and being able to build solutions that might start with weather but don’t end with weather. How do we enrich it with cognitive technology, and how do we put that to use for our clients?Hays: Watson also is getting into the business of advertising. As if agencies and advertisers don’t have enough threats, here comes artificial intelligence. Tell us how AI has impacted advertising generally and what role IBM and Watson are playing in that field.Bitterman: At IBM when we talk about AI, we don’t actually use the term artificial intelligence. We use the term augmented intelligence. It might sound like marketing spin, but words matter. When we think about augmented intelligence, we don’t think about any of the solutions that we have putting agencies or putting anyone out of business. We actually see it as benefitting them. If we go back to the programming era, computers didn’t put advertising agencies out of business. Computers spawned an entirely new way to do advertising, both to display advertising but also to go about creating media plans, etc.

We think about how AI needs to be put to use in the advertising world. We started out with something we called Watsons Ads, and it’s a creative tool in a lot of ways. You could think of it as one of the world’s coolest rich media units, and you probably know rich media as just a more robust kind of creative technology. When we launched Watson Ads just about a year ago, we did so with the idea that much like Watson itself, which is all about learning and understanding and reasoning and interacting, our ads would be able to do the exact same thing. Picture an ad wherever you are, on a mobile device or on a website. We’ve all seen the ads, and a lot of times we don’t want to interact with the ads because we feel like they aren’t helpful to our session on our mobile devices. They’re actually hurtful. They’re interruptive. But in this case, we want them to be conversational. We want to bring value to people. For instance, with Campbell’s, you are able to tell the ad what ingredients you have in your home, and the Watson ad will give you a recipe that you can make with those ingredients. What makes it cognitive is that the ad can’t possibly know all the combinations that you’re going to ask. It doesn’t know that you have leeks, curry and chicken. But it’s cognitive, so it learns the kinds of things that are great combinations to put together. It works by giving you a helpful result, and it gets smarter as it learns.Hays: Is that voice activated?Bitterman: Yeah, it doesn’t have to be. You can type into it. But one of the really interesting aspects of cognitive technologies is that it does have natural language recognition skills, so a lot of the clients that we’ve worked with on Watson Ads have taken advantage of that API. Because why not, why wouldn’t you want to give people that option?Hays: Especially if you’re starting to cook. Your hands are dirty and you don’t want to type. Voice interface makes a ton of sense in many applications.Bitterman: It does. We see that with Amazon with the Echo, and we see it with Google with Home. Those are very much consumer applications. IBM and Watson are not in the consumer business. The Weather Channel does have consumer apps, but for the most part when we put Watson to work, even on our own properties, we’re doing it with the idea that it’s a solution for enterprise that we will take advantage of. In this case for Watson Ads, it’s a solution that Campbell’s or GlaxoSmithKline or whomever can take advantage of to interact with their customers.Hays: You’re redefining what an advertisement is, which is part of what we talk about all the time and why we called our book Beyond Advertising, because it is creating value. It’s not the typical ad. You’re not saying that it’s trying to come up with whether it’s red or pink or yellow, whether it’s a bull or a chicken or something else. You’re saying that it’s this interface, this interaction between the audience and the brand where something good is happening for both.Bitterman: We are not shying away. In fact, we are going to have more products, more cognitive advertiser offerings that we’re going to be launching in just about a month. But we started out with one that we thought Watson Ads, the creative that I just described, would do a really good job of emotionally connecting not only with the audiences that our clients are trying to reach, but also our clients themselves. For them to understand this is where the future of advertising is going. Watson Ads has been able to telegraph that in a very meaningful way.Hays: Are you finding advertisers generally hesitant or excited about AI?Bitterman: It varies, which I know is the worst answer to ever get. It depends. The most innovative brands are leaning in very hard on Watson Ads because they see it as an opportunity in exploring new technologies and using our technology to engage audiences in new and breakthrough ways. But building a Watson ad takes a little bit of time and a very considered approach. If you have a marketing team of two and a lot of things that you’re trying to accomplish, then you’ve just got to stay real focused on getting those things done.But if you’re a bigger brand — Campbell’s, GlaxoSmithKline, Toyota and Unilever have all worked with us — they have higher risk thresholds because they are open to trying things and experimenting. I don’t mean to suggest that what we’re doing won’t work, but it certainly takes a leap of faith. It’s not the first thing on your plan. Just like me as a marketer, the first thing on my plan is the acquisition marketing. What is going to drive revenue or drive traffic to our consumer properties? I need to have bigger budgets and a bigger risk threshold to try to ride the crest of the wave and do something new and different and move into the future of advertising. The bigger clients understand that.

Hays: It’s almost riskier at this point not to start jumping into the game, not to start understanding how it can be relevant for your business and how it can enhance what you’re doing from a marketing perspective. Do you think it’s too early for some companies, or do you think everybody should at least try getting started in this field?Bitterman: I’ve been in our business a long time, and I’ve got the gray hairs to prove it, and I’ve had the good fortune to have lived through the digital revolution and the mobile revolution and the social revolution. If you think about all of those parts of our industry, those times of our industry where we have seen so much change, we have arrived at a place now where all three of those areas — digital, mobile, social — are all mature industries.I do remember working with colleagues and with clients when I was on the agency side who were either indifferent to those areas or were sort of scared of those areas. Those areas have all become big businesses with anywhere from two to five billion people on the planet consumed by it. But if you think about AI, AI is going to consume the total population of the planet. The reason why that’s true is because you don’t necessarily opt into AI the way you opt into social when you create a Twitter account or a Facebook account. You either opt into AI because you’re wearing a Fitbit or you’re giving a company permission to use the data that’s coming out of your dishwasher or it’s working with you in an ambient way. It’s changing the traffic light grid in your city. Whether we know it or not, whether we opt in or not, AI is touching all of us and will touch every person on the planet.Hays: It’s what’s powering some of the most interesting technologies. As you were saying before, you can’t have IOT without augmented intelligence. In that regard, it truly is becoming pervasive. So how about the risks, especially from an ambient perspective, something that you’re not opting in but it is checking your biometrics as you’re walking past? What are the risks that you are seeing and the responsibility that a company like IBM has?Bitterman: Our company has an ethical and moral standard that is unlike I’ve ever seen before. Some days in my job it actually frustrates me a bit because the bar is so high in terms of what we can put out and what we can’t. But even though the day to day can be frustrating on that particular topic sometimes, it’s really best that we have big companies that think that way.Back during Mobile World Congress in the spring, the CEO of SoftBank had a slide up in his presentation, and he said that there were 12 threats to civilization. One of them was AI. But he said the only threat among the 12 that actually is an antidote to the other 11 is AI. AI can help solve those challenges. We do have to regulate, and I believe that the government is behind in even thinking about this. Companies at this point are self-regulating, and that’s a good thing. We’ve got a lot of companies in our world that have great intentions and they’re on it. They might not be on it all the way, but I know I can speak for IBM when I can say that we are. But over time, we as a society have to think about these things. What are the challenges that we want to solve for? And let’s make sure that while we’re solving for some of those challenges we’re not creating new challenges in the process.Hays: Could you tell us about the Toyota ad campaign and what you learned from it as we’re at these early stages of augmented intelligence.

Bitterman: Sure. You can ask the ad pretty much any question you want about the Prius. For instance, I wondered about the charging process. I live in New York City and my garage doesn’t necessarily have access to special charging docks. I asked it a series of questions in my own voice as to how I need to charge, what kind of outlets I need to use, how long does a charge take, how long does it last? All those answers came back, similar to when we were talking about Campbell’s and the ingredients. But they get you to a point where you feel more connected to the brand, to the specific model. As a marketer, I know my job is to diminish the distance that exists between an audience member, a customer and a sale. If I can find the way to diminish that distance, to make that point A to B shorter, in this case get people to come in and take a test drive, then I’ve done my job. That’s what Toyota Prius and their Watson ad is all about.I can’t speak to Toyota specifically because that would be their right, it’s their data. But I can tell you in aggregate when we look at the various Watson ads that we’ve created, a number of things have happened. No. 1, we’re seeing one to two minutes of active engagement with the ads on average. Some people spend a lot more time with it. But one to two minutes with an ad is a lot of time. That exceeds digital industry time-spent benchmarks.We’re also revealing lots of interesting product insights, like consumers tend to engage more deeply when they’re submitting what we might call non-intuitive ingredients for a recipe suggestion, or when they’re asking questions that are outside of the box of what someone might normally engage in with an ad for a car manufacturer. Not only do all those things they help an advertiser understand how the ad is working, but it also could create lots of insights for how they might want to revamp their product brochure or their social strategy. Because these are all tells that couldn’t be had in any other way.Hays: Speaking of humanizing these sorts of things, if the Watson ad gets flummoxed and you have a question that it doesn’t know how to answer, is there a human interface?Bitterman: It’s all in how you architect the ad itself, but the ad keeps working. It keeps trying to answer your question. It will ask you to ask it in a different way. It will give you a suggestion. When we architect the ads, we want to make sure that we’re deep-linking people into a very specific experience based on what we’re hearing about them. You can think that the technology that’s in a Watson ad could absolutely take someone deeper, that you are basically closing the sale or taking someone further from engagement into consideration, or from consideration into purchase. The goal is, how do we get people and diminish that distance between where they are now and where they need to be?Hays: What do you see as the top three trends that we should be looking out for in this space?Bitterman: You mentioned before the issues around privacy and security. All of us in this industry need to be thinking about that because if we don’t, it’s going to be done for us. It will probably be done for us anyway, but we should be building an ecosystem that is really right for the long term, for what we want to build, not just for where we are right now.I think we need to focus. Focusing is very important. Right now, AI is very large and kind of like digital in itself. Back in the day someone would ask, how much does a website cost? How much time does it take to build a website? This goes back to the early to mid-1990s. Right now, some of those same very broad questions are being asked to AI. Do I need AI? How much does an AI ad cost? The goal here has to be to focus. We have to be able to focus both as a provider of AI services, but also as marketers who are out there trying to engage with us. We have to both sell more focus and we have to buy more focus in order to get to where we need to go.

If you know the other and know yourself, you need not fear the result of a hundred battles.

Sun Tzu

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.